Even if you maintain a household in one of the possessions discussed
in this publication that is your main home and the home of your qualifying
child, you cannot claim the earned income credit on your U.S. tax return. This
credit is available only if you maintain the household in the United States or
you are serving on extended active duty in the U.S. Armed Forces.

U.S. military personnel stationed outside the United States on
extended active duty are considered to live in the United States during that
duty period for purposes of the EIC. Extended active duty means you are called
or ordered to duty for an indefinite period or for a period of more than 90
days. Once you begin serving your extended active duty, you are still considered
to have been on extended active duty even if you do not serve more than 90 days.

Deductions that specifically apply to your excluded possession
income, such as employee business expenses, are not allowable on your U.S.
income tax return.

Deductions that do not specifically apply to any particular type
of income must be divided between your excluded income from sources in the
relevant possession and income from all other sources to find the part that you
can deduct on your U.S. tax return. Examples of such deductions are alimony
payments, the standard deduction, and certain itemized deductions (such as
medical expenses, charitable contributions, real estate taxes, and mortgage
interest on your home).

Generally, expenses of a move to a possession are directly attributable
to wages, salaries, and other earned income from that possession. Likewise, the
expenses of a move back to the United States are generally attributable to U.S.
earned income.

If you are claiming expenses for a move to a relevant possession,
how and where you will deduct the expenses depends on your status as a bona fide
resident and if any of your possession income is excluded on your U.S. tax
return. For more information, see
Moving expense deduction in
chapter 3 under the name of the relevant possession.

If you are claiming expenses for a move from a U.S. possession
to the United States, use Form 3903 to figure your deductible expenses and enter
the amount on Form 1040, line 26. For purposes of deducting moving expenses, the
possessions are considered part of the United States. See Publication 521,
Moving Expenses, for information about what expenses are deductible.

Generally, if you are reporting self-employment income on your
U.S. return, you can deduct one-half of your self-employment tax on Form 1040,
line 27. This is an income tax deduction only; it is not a deduction in figuring
net earnings from self-employment (for self-employment tax).

However, if you are a bona fide resident of American Samoa or
Puerto Rico and you exclude all of your self-employment income from gross
income, you cannot take the deduction on Form 1040, line 27, because the
deduction is related to excluded income.

If only part of your self-employment income is excluded, the
part of the deduction that is based on the nonexcluded income is allowed. This
would happen if, for instance, you have two businesses and only the income from
one of them is excludable.

For purposes of the deduction only, figure the self-employment
tax on the nonexcluded income by multiplying your total self-employment tax
(from Schedule SE (Form 1040), Self-Employment Tax) by the following fraction.

Self-employment incomesubject to U.S. income tax

Total self-employment income(including excluded possession income)

The result is your self-employment tax on nonexcluded income.
Deduct one-half of this amount on Form 1040, line 27.

The standard deduction is composed of the regular standard deduction
amount and the additional standard deduction for taxpayers who are blind or age
65 or over. For 2010, you can add to these amounts certain new motor vehicle
taxes and a net personal disaster loss attributable to a federally declared
disaster (see the Form 1040 instructions for line 40). None of these deductions
apply to any particular type of income.

To find the amount you can claim on Form 1040, line 40, first
figure your full standard deduction according to the instructions for Form 1040,
which may include completing Schedule L, Standard Deduction for Certain Filers.
Then multiply your full standard deduction by the following fraction.

Gross income subject to U.S. income tax

Gross income from all sources(including excluded possession income)

In the space above line 40, enter "Standard deduction modified
due to income excluded under section 931 (if American Samoa) or 933 (if Puerto
Rico)." If you completed Schedule L, attach it to your return.

This calculation may not be the same as the one you used
to determine if you need to file a U.S. tax return.

Most itemized deductions do not apply to a particular type of
income. However, itemized deductions can be divided into three categories.

Those that apply specifically to excluded income, such as
employee business expenses, are not deductible.

Those that apply specifically to income subject to U.S. income
tax, which might also be employee business expenses, are fully allowable under
the instructions for Schedule A (Form 1040), Itemized Deductions.

Those that do not apply to specific income must be allocated
between your gross income subject to U.S. income tax and your total gross income
from all sources.

The example given later shows how to figure the deductible part
of each type of expense that is not related to specific income.

In 2010, you and your spouse are both under 65 and U.S. citizens
who are bona fide residents of Puerto Rico during the entire tax year. You file
a joint income tax return. During 2010, you earned $20,000 from Puerto Rican
sources (excluded from U.S. gross income) and your spouse earned $60,000 from
the U.S. Government. You have $16,000 of itemized deductions that do not apply
to any specific type of income. These are medical expenses of $4,000, real
estate taxes of $5,000, home mortgage interest of $6,000, and charitable
contributions of $1,000 (cash contributions). You determine the amount of each
deduction that you can claim on your Schedule A (Form 1040), Itemized
Deductions, by multiplying the deduction by the fraction shown under
Figuring the deduction, earlier under
Deductions if Possession Income is Excluded.

Medical Expenses

$60,000$80,000

×

$4,000

=

$3,000
(enter on line 1
of Schedule A)

Real Estate Taxes

$60,000$80,000

×

$5,000

=

$3,750
(enter on line 6
of Schedule A)

Home Mortgage Interest

$60,000$80,000

×

$6,000

=

$4,500
(enter on line 10 or 11 of
Schedule A)

Charitable Contributions (cash contributions)

$60,000$80,000

×

$1,000

=

$750
(enter on line 16of Schedule A)

Enter on Schedule A (Form 1040) only the allowable portion of
each deduction.

If you must report American Samoa or Puerto Rico source income
on your U.S. tax return, you can claim a foreign tax credit for income taxes
paid to the possession on that income. However, you cannot claim a foreign tax
credit for taxes paid on possession income that is excluded on your U.S. tax
return. The foreign tax credit is generally figured on Form 1116.

If you have income, such as U.S. Government wages, that is not
excludable, and you also have possession source income that is excludable, you
must figure the credit by reducing your foreign taxes paid or accrued by the
taxes based on the excluded income. You make this reduction for each separate
income category. To find the amount of this reduction, use the following formula
for each income category.

Excluded income from possession sources less deductible expenses
based on that income

x

Tax paid or accrued to the possession

=

Reduction in foreign taxes

Total income subject to possession tax less deductible expenses
based on that income

Jason and Lynn Reddy are U.S. citizens who were bona fide residents
of Puerto Rico during all of 2010. They file a joint tax return. The following
table shows their excludable and taxable income for U.S. federal income tax
purposes.

Taxable

Excludable

Jason's wages from
U.S. Government

$25,000

Lynn's wages from Puerto Rican
corp.

$15,000

Dividend from Puerto Rican corp. doing business in Puerto
Rico

200

Dividend from U.S.
corp. doing business
in U.S.*

1,000

Totals

$26,000

$15,200

* Income from sources outside Puerto Rico is taxable.

Jason and Lynn must file 2010 income tax returns with both Puerto
Rico and the United States. They have gross income of $26,000 for U.S. tax
purposes. They paid taxes to Puerto Rico of $4,000 ($3,980 on their wages and
$20 on the dividend from the Puerto Rican corporation). They figure their
foreign tax credit on two Forms 1116, which they must attach to their U.S.
return. They fill out one Form 1116 for wages and one Form 1116 for the
dividend. Jason and Lynn figure the Puerto Rican taxes on excluded income as
follows.

Wages: ($15,000 ÷ $40,000) × $3,980 = $1,493

Dividend: ($200 ÷ $200) × $20 = $20

They enter $1,493 on Form 1116, line 12, for wages and $20 on
the second Form 1116, line 12, for the dividend.